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USING THEORETICAL CAPACITY TO ELIMINATE MANIPULATION OF ABSORPTION COSTING INCOME

Cost management, 2007-09, Vol.21 (5), p.40

Copyright Thomson Professional and Regulatory Services, Inc. Sep/Oct 2007

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  • Title:
    USING THEORETICAL CAPACITY TO ELIMINATE MANIPULATION OF ABSORPTION COSTING INCOME
  • Author: Sopariwala, Parvez R
  • Subjects: Absorption costing ; Accounting ; Capacity ; Costs ; Earnings ; Earnings management ; Financial reporting ; Inventory ; Lean manufacturing ; Measurement techniques ; Net income ; Overhead costs ; Stockholders ; Work in process
  • Is Part Of: Cost management, 2007-09, Vol.21 (5), p.40
  • Description: It is well established that absorption costing income (the income measurement technique used for financial reporting) can be managed or smoothed by varying production levels. Earnings can be increased by producing more than needed to satisfy sales demand, thereby building up work-in-process and finished goods inventories. Alternatively, earnings can be decreased by producing less than needed to satisfy sales demand. Using Eli Goldratt's "evaporating cloud" methodology, they attempt to resolve a paradox: whereas keeping work-in-process and finished goods inventories low is preferable for operations, keeping work-in-process and finished goods inventories high is often better for financial reporting, and possibly stock prices. To remove all inventory-related incentives for earnings manipulation, a new injection is discussed whereby fixed overhead rates are determined using a theoretical capacity measure, which allows for the determination of operating income and the cost of idle capacity for determining net income.
  • Publisher: Boston: Thomson Reuters (Tax & Accounting) Inc
  • Language: English
  • Source: Alma/SFX Local Collection
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